Allison Bertelson/Minneapolis Fed
To understand what blockchain is, how it works and why it matters, you don’t necessarily need a degree in computer science. Instead, just think about your family tree.
Let’s say you want to learn about your ancestry. You could begin by asking your mom, dad or Aunt Jenny. But what if you want a more reliable source? What if you want a tamper-resistant record that lasts over time and doesn’t require you to guess if Aunt Jenny’s memory or your mom’s is more reliable? That record exists: It’s our DNA.
Blockchain—the underlying technology first developed to support Bitcoin—creates a record analogous to the way DNA is recorded in our genetic code. Each new individual added to our ancestral chain is linked to the ones who came before through genes we inherit. And that, it turns out, is one of the key properties of a blockchain.
Bitcoin—and other digital currencies—enables the exchange of value between two parties, but without a bank or other intermediary in between. The typical role of a bank in transactions is to authenticate the user and validate an available balance, making sure money isn’t spent twice. A blockchain takes over that role in digital currency transactions.
To make digital currency work, Satoshi Nakamoto, a pseudonym for the inventor(s) of Bitcoin, had to find a new way to authenticate transactions and prevent what’s known as “double spending.” To do so, Nakamoto brought together several known technologies: cryptography, accounting, distributed computing networks and incentive structures, calling the resulting platform a “chain of blocks” in a 2008 white paper. But he, she or they (no one really knows who Nakamoto is) probably didn’t have the human genome in mind when designing the system. Nevertheless, a genetic family tree is a helpful analogy for understanding what makes this technology a useful tool.
A database for information
Blockchain, like a gene, is a database that holds information. However, rather than a sequence of DNA passed from generation to generation, blockchain forms the link through cryptography—the science of “secret writing.”
Protecting and authenticating data
Cryptography performs several functions in a blockchain database. For example, it provides validation that the entity or person wishing to initiate a transaction is authorized to do so.
Cryptography also includes the ability to instantly tell if the underlying data in a particular transaction have been altered and, if so, at which point in the chain the alteration occurred. It’s like being able to pinpoint in a family’s genealogy when a mutation was introduced. The family members before the mutation wouldn’t show symptoms; only those afterward would.
Blockchain protects the integrity of data and makes it very difficult to tamper with transaction history. By doing all of this with math, eliminating the need for a central authority to authenticate the data or maintain the record, blockchain offers some interesting opportunities for organizations to explore.
One way a Ninth District company is testing blockchain
United Health Group and its Optum unit recently announced a partnership with other companies to improve physician directories with a blockchain solution. Because blockchain offers a tamper-resistant way to secure data, it may help streamline operations for health care industries’ back-office processes. Inaccurate databases cause unpaid patient claims and additional work for physicians and staff. A blockchain, or blockchain-inspired platform, could ensure the authenticity of the data once entered. It could also provide a single source of truth for multiple parties to access without any one partner owning the role as “administrator” or central authority. The project is a pilot at this point, with findings planned to be announced in the fall, according to Forbes.com.
Like Optum’s project, most blockchain platforms and related applications aren’t ready for widespread use. Some companies could benefit from the technology in the future, but now “there are so many different implementations and variations of blockchain,” says David Schwietz, vice president of Information Technology at the Federal Reserve Bank of Minneapolis, “that organizations have a hard time determining where to start, let alone understanding what strategies to use.”
Interoperability, scalability, security, technological immaturity and stakeholder alignment are all considerable impediments to realizing blockchain’s potential. “Supporters [of using blockchain technologies] do need to make sure they are actually solving a real problem within the context of industry-specific regulatory requirements,” cautions Brad Berning, senior research analyst in financial technology at Craig-Hallum Capital Group in Minneapolis.
For some, rushing to use a new technology without having a clearly defined business case and an understanding of the maturity of the tool can mean wasted time and money without results. For example, Chris Swanson, senior vice president of Innovation Research and Development at US Bank, recommends a thoughtful approach. Interoperability between existing systems and a new blockchain platform or across blockchain platforms must be carefully evaluated. The risk, Swanson warns, is “re-creating the same problems banks [and other institutions] have today in a fancier wrapper.”
The real value of this technology may not be unlocked until applications that use a blockchain platform arrive and take hold. Academic institutions, for instance, have initiated projects like MIT’s Cryptokernel to make experimentation easier and encourage “everyone” to learn more and develop new ideas with blockchain technology. Universal digital identity and reputation management systems are often-cited examples of applications powered by a blockchain platform. Another is faster, cheaper cross-border payment services. Howard Shultz, former Starbucks CEO, commented in a February interview about the future of their popular payment application: “I think blockchain technology is probably the rails in which an integrated app at Starbucks will be sitting on top of.” Coffee, identity, payments or perhaps some new idea born from innovators using MIT’s toolkit may be the next big thing in blockchain.
Finally, consider that DNA was discovered in 1869, but only in the past 20 years has DNA testing evolved to the point of being able to prove Aunt Jenny right or wrong about your family tree. It could be years before we realize the potential of blockchain. Or it could be soon. We’ll have to wait and see.
Angela Lawson is the senior payment consultant for emerging technologies in the Payments, Standards, and Outreach Group at the Federal Reserve Bank of Minneapolis and a contributor to several payment industry white papers.